Construction of Commercial Contracts

This post is part of our contract law series. If you are interested in understanding some of the common clauses found in commercial contracts, refer to the following:

In an ideal world commercial contracts would be perfectly drafted, setting out a clear path for the parties for performance and the achievement of their commercial objectives. Certainty in construction should lead to predictability in the outcome of any dispute about its terms and performance.

In the real world however, the quality of a commercial contract is a function of the time and cost expended on drafting it. Businesses do not have unlimited time to enter into contracts nor unlimited budgets to engage suitably qualified lawyers. As a consequence, a good proportion of commercial contracts are poorly drafted and are littered with ambiguity and error.

Oftentimes a poorly drafted contract becomes the centre of a legal dispute between parties in court. Courts are tasked with the responsibility for untangling competing potential meanings. Below we discuss some of the methods used by courts in Australia in the construction exercise.

Mount Bruce Mining

The High Court in Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd [2015] HCA 37 set out the ‘current state’ of the law of contract interpretation. In this case, the High Court found that:

“rights and liabilities of parties under a provision of a contract are determined objectively, by reference to its text, context (the entire text of the contract as well as any contract, document or statutory provision referred to in the text of the contract) and purpose.” 

and further:

“that enquiry would require consideration of the language used by the parties to the contract, the circumstances addressed by the contract and the commercial purpose or objects to be secured by the contract.” 

In summary, Mount Bruce Mining confirmed the need to look at the text and context of the contract itself as well as the purpose evidenced by the language used by the parties, the contract itself and any other document referred to in the text of the contract.

The Mount Bruce Mining decision is important but should be read alongside other decisions, some of which are discussed below.

 Ecosse Property Holdings Pty Ltd

The above principles were affirmed in Ecosse Property Holdings Pty Ltd v Gee Dee Nominees Pty Ltd (2017) 261 CLR 544; [2017] HCA 12 where the majority of the High Court stated as follows at paragraphs [16]-[17]:

“[16] It is well established that the terms of a commercial contract are to be understood objectively, by what a reasonable businessperson would have understood them to mean, rather than by reference to the subjectively stated intentions of the parties to the contract. In a practical sense, this requires that the reasonable businessperson be placed in the position of the parties. It is from that perspective that the court considers the circumstances surrounding the contract and the commercial purpose and objects to be achieved by it.

[17] Clause 4 is to be construed by reference to the commercial purpose sought to be achieved by the terms of the lease. It follows, as was pointed out in the joint judgment in Electricity Generation Corporation v Woodside Energy Ltd, that the court is entitled to approach the task of construction of the clause on the basis that the parties intended to produce a commercial result, one which makes commercial sense. It goes without saying that this requires that the construction placed upon cl 4 be consistent with the commercial object of the agreement.”

Ordinary, natural meaning

A court will start by looking at the ‘ordinary, natural meaning’ of the terms in dispute. The general approach followed by judges is to interpret commercial contracts ‘fairly and broadly, without being too astute or subtle in finding defects.’[1]  The construction exercise will not necessarily cure a bad deal. Looking at the ordinary natural meaning of the words used may result in a ‘poor bargain’ inconsistent with what one may expect that commercial parties would expect.[2]

It has been recognized that while words have a natural meaning that applies in most situations, meaning is not derived in isolation from the context in which words are used. An interpretation that focuses on semantic and syntactical analysis leading to a construction that is contrary to business common sense will generally be avoided.[3]

When interpreting a contract, a court will have regard to the words used ‘so as to render them all harmonious with one another.’[4] In other words, a court will prefer a construction of the disputed terms that is congruent with the various other components of the contract. Words in a commercial agreement will be construed by reference to what a ‘reasonable business-person’ would have understood those terms to mean.[5] The relevant context in which the meaning of the words will be construed includes the terms of the contract and the objective facts surrounding the formation of the contact provided that those objective facts are known to all of the parties to the contract.

The rule that words should be given ordinary natural meaning is reflective of the proposition that parties to a contract are presumed to be capable of expressing their intentions. Where words are ambiguous, resort may be had to the surrounding circumstances to determine the meaning when choosing between two inconsistent meanings. Generally speaking, however, if the language used in a contract is unambiguous, a court will give effect to that language unless to do so would be to give the contract an absurd operation.[6] As you can imagine there have been a number of cases where the tension between the ordinary and natural meaning comes up against the business common sense.

Tools to assist in understanding the meaning of the words used

Courts may use a number of aids to assist in the interpretation of a contract. Firstly, where language is used that enjoys a settled meaning, courts will endeavor to adhere to such a meaning. Secondly, courts may use dictionaries and other materials to determine the conventional meaning of a word.[7] However, a dictionary whilst potentially used as a guide, will not be used as a substitute for the interpretive processes.[8]

Where a word is given meaning by statute, subject to a contrary provision in the contract, the meaning of the statutory term at the time of the contract will usually be accepted.[9]

Finally, where a word has both an ordinary meaning and a technical meaning, it will be given the ordinary meaning unless there is evidence that the parties intended to use the word’s technical meaning.[10] However, where a word has a technical legal meaning, it will usually be given that technical legal meaning unless there is a clear indication in the contract or the context of the contract that this is not what was intended. This presumption is particularly strong where a contract has been drawn up by lawyers.

Canons of construction

There are a number of widely accepted maxims or canons of construction that courts use to assist them in ascertaining the meaning of a contract. These canons can be considered as guidelines or aids in the construction process.[11] Some of the commonly used canons of construction are set out below.

The contract should be construed as a whole: this is a principle often cited in judgments which says that the meaning of a term should be considered against the context provided within the contract as a whole.[12]

A court should give effect to all parts of the contract: this means that each part of a contract must be considered when determining the meaning of the contract as a whole.[13] In applying this maxim, a court will endeavor to resolve internal inconsistencies by both giving effect to provisions capable of being read together or by qualifying one against the other.[14]

Express mention of a part of a subject matter implies that other matters are deliberately admitted: this means that where a contract expressly mentioned something but ommits others within the same class, it can be implied that the matters not mentioned are excluded.[15]

An expressed term excludes implication of a term on the same subject matter: this means that a term will not be implied if it is inconsistent with the expressed terms of the contract.

Noscitur a sociis: a word of ambiguous meaning may obtain meaning from the surrounding words if they have a common characteristic. This rule will apply where a genus for the words is identifiable by if words fall within a particular class then the word that is potentially ambiguous can be assumed to form part of that class.

Contra proferentem rule: where the meaning of a contract is ambiguous the words that are in dispute will be construed against the party who drafted the contract. There are conflicting views as to whether this maxim means that construction should favor the party who prepared the contract or should favor the party against whom benefit is provided. Courts have expressed the view that the contra proferentem rule applies only when having applied all other aids to construction and ambiguity remains.[16] In other words, this maxim is only used as a last resort when seeking to interpret a contract. This maxim commonly applies in the interpretation of guarantees and indemnities where courts have found that ambiguous provisions should be construed in favor of the guarantor.

A party may not take advantage of their own wrong: a contract will not be interpreted in such a manner as not to permit one party to take advantage of their own wrong. In other words, it will be presumed that a contractual entitlement arising from the occurrence of a particular event will not be enlivened if the event came about through the breach of the party seeking to rely upon it.[17]

Saving the document: where there are two possible constructions of a document, a court will favor the interpretation that retains rather than destroys the bargain.

[1] Hillas & Co Ltd v Arcos Ltd [1932] All ER 494.

[2] Cherry v Steele-Park [2017] NSWCA 295.

[3] Breakout Barrier Release Systems Pty Ltd v Breakout Barrier Release Systems Australasia Pty Ltd [2013] NSWSC 1815

[4] Australian Broadcasting Commission v Australasian Performing Rights Association Ltd (1973) 129 CLR 99, 109

[5] Wilkie v Gordian Runoff Ltd [2005] 221 CLR 522, 529

[6] Jireh International Pty Ltd [t\as Gloria Jean’s Coffee] v Western Export Services Inc. [2011] NSWCA 137

[7] House of Peace Pty Ltd v Bankstown City Council (2000) 48 NSWLR 498

[8] Provincial Insurance Australia Pty Ltd v Consolidated Wood Products Pty Ltd (1991) 25 NSWLR 541.

[9] Smith v South Wales Switchgear Co Ltd (1978) 1 WLR 165.

[10] CCOM Pty Ltd v Jiejing Pty Ltd (1992) 36 FCR 524, 528

[11] Ferdinands v Commissioner for Public Employment (2006) 225 CLR 130.

[12] Australian Broadcasting Commission v Australasian Performing Rights Association Limited (1973) 129 CLR 99.

[13] RE Media Entertainment and Arts Alliance; Ex parte Hoyts Corp Pty Ltd (1) (1993) 178 CLR 379.

[14] RE Media Entertainment and Arts Alliance; Ex parte Hoyts Corp Pty Ltd (1) (1993) 178 CLR 379.

[15] ABB Power Plants Limited v Electricity Commission of New South Wales (1995) 35 NSWLR 596.

[16] Sandbank Holdings Pty Ltd v Durkan (2010) WASCA 122

[17] Ruthol Pty Ltd v Tricon (Aust) Pty Ltd (2005) 12 BPR 98.

Who to Contact for More Information

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